Is This a Bull, a Bear, or What? // May 31, 2016

Posted on May 31, 2016

Weekly Update5/31/2016

Market State 7 (Transitional) & Portfolio State 1 (Bullish): The Portfolio Thermostat’s “Market State” is a reflection of the S&P 500’s current market environment (i.e. bullish, transitional or bearish), according to the following indicators.

Portfolio State 1: Is representative of a low risk portfolio based on the current market environment. Since the overall Market State (MS 7) is transitional, the current Portfolio Thermostat model is diversified in a way to remain stable regardless of the markets short term action. Therefore, the emphasis is on the portfolio’s efficiency and not the individual holdings.

MarketComment:
The market, referring to the S&P 500, is only 1.7% away from breaking above its 52-week high of 2131 back in May (the 21st) of 2015. But what about the other market indices? The NASDAQ composite is down -5.7% from its 52-week high; the Russell 2000 is down -11.2% and the Dow Jones Transport index is down a whopping -16.5% from its all-time high. No new highs mean that none of the major equity markets have made money in over a year.

Consider the implications of this within the context of the three things that matter about short-term performance, which are:

We only make money when the “portfolio” registers a new high in value.

The total number of new portfolio highs will be more frequent and more sustainable when effective risk management can limit declines to normal corrections in the -8% to -12% range.

Portfolio declines in excess of -15% from the peak are considered to be a failure in risk management.

Virtually every major equity market index around the world has had a peak-to-trough decline of -20%, or more, over the last trailing 52 weeks.

The S&P 500 is currently at about the 2,100 resistance level that it was at in July and November of last year. The 2100 level was tested again this year during April and now the market is trying once again to punch through the old May 21st high. So now what?
Carter Worth, CMT, (a friend of Canterbury’s) has been named as one of the very top market technicians by institutional investors from around the world. Carter recently researched the question: What is likely to happen following a “calendar year” when the market fails to put in a new 52-week high?

By studying every period, going back to 1928, he was able to identify every year that the market failed to register a new high during the 52-week period. He then examined the market’s returns for the following 52-weeks (the next year). Here is what he found:

According to Carter’s work, going back to 1928:

The S&P 500 has made an average of 23 new 52-week highs during a calendar year.

The market’s average return has been about 7.4% (SPX: 1928-2015)

“The probability of the market ending positive in any given year is 70%.”

The market has gone without making a new 52-week high in 19 out of 88 years (21.6% of the time).

He found that of the “19 calendar years, when the SPX made no new 52-week highs, the Index was down -15.8% for the entire calendar year.” Of those 19 years, there were 17 down years and 2 unchanged. In addition, Carter found that the following year after the unchanged or down year (the second year) has averaged -7.9%.

Summary of Carter Worth’s study:
If we make no new 52-week highs (we’ve made none so far this year), the chances are high (89.5%) that the year ends in negative territory.

So what if the S&P 500 does hit a new high surpassing 2132.82 of May 21st, 2015, sometime during this year? “Turns out, even if we do make a handful of new highs or more (but below the average), the market ends up lower for the year, down -2.6%.”

Is the current market environment a bull, bear or what?
It is easy to get caught up in the day-to-day noise of the markets. The bottom line, however, is that the long-term upward trend of the S&P 500 is broken and has been broken for several months. Almost every other major equity market index looks worse than the S&P 500.

No human or sophisticated set of algorithms can predict the future. That being said, we do have statistical evidence that shows we can identify the existing market environment and that we can determine a market’s, or a portfolio’s, likelihood of exceeding the normal market noise (a correction up to 8% to 12%).

The current market has many of the characteristics of market environments that have eventually suffered substantial losses. We call this market environment “Transitional.” Given enough time, the sideways trading range could heal the technical damage that has been inflicted over the last year. On the other hand, “Transitional” market environments can also represent very high risk of substantial declines. The key point is that Portfolio Thermostat model is currently diversified to produce a low risk and efficient portfolio to match the current environment.

The S&P 500’s long term up-trend was broken in late 2000

The S&P 500’s long-term up-trend was broken in early 2008

The S&P 500’s long-term up-trend was broken in late 2015Source: AIQ

More About Tom Hardin

As Chief Investment Officer, Tom has more than 30 years of experience in the investment management industry and has a broad breadth of knowledge. He is known as an innovator, educator and has been revolutionary in the advancements of portfolio and risk management.

Disclaimer
Every effort was used to provide accurate data and mathematical calculations to provide, what we believe to be, accurate results. Canterbury Investment Management, LLC, and its principal owners, make no guarantee of completeness or accuracy of data or calculations as well as conclusions of any statistical data or information contained in the simulation illustrated on this page. Past results or performance is in no way a guarantee of future results.